Site Mobile Navigation

On Paper, Prudential Gets a Lift

Investors eagerly looking for the “green shoots” of a recovery lapped up the news when Prudential Financial announced this month that it was profitable again, after six months of big losses.

The insurer’s stock jumped nearly 30 percent in the two days after its earnings report. What was largely overlooked: the first-quarter profit came solely from accounting.

Prudential was an early adopter of a new accounting guideline that gives all companies greater flexibility in valuing their sagging investment portfolios. Without the change, Prudential would have reported a loss of at least $400 million for the quarter instead of a $14 million profit, according to Peter Larson, an analyst with Gradient Analytics, a firm that examines the quality of corporate financial reporting.

Prudential did nothing wrong; it just acted very quickly — all companies that report their earnings on the calendar year are expected to adopt the new accounting method in the second quarter. But Prudential’s move shows how helpful the change may prove to be, especially for life insurers, which tend to buy and hold assets like commercial real estate, whose values have fallen.

The new accounting method can not only help the bottom line, but also obscure an insurer’s true capital position, a crucial measure of its financial strength. Prudential’s bigger rival, MetLife, has not yet adopted the change and says it is still studying what the effect will be.

“We do think this is going to benefit a lot of companies,” Mr. Larson said. “Prudential is one of the first.”

Another accounting analyst, David Zion of Credit Suisse, said it was impossible to predict whether other insurers would have big swings like the one at Prudential.

“It’s not like the disclosures are perfect,” Mr. Zion said. “I could have the same security accounted for three different ways” at three different companies.

MetLife has not sought government aid, but a half-dozen other life insurers, including Prudential, have recently been approved for federal assistance and are wrestling with whether to accept the money. If Prudential’s stock price holds up, the company should be able to raise money elsewhere, thereby avoiding the limits on executive bonuses, heightened public scrutiny and other pitfalls of the Treasury’s Troubled Asset Relief Program, or TARP.

The Hartford Financial Services Group and Lincoln National Corporation are among the insurers being offered government assistance. Allstate Corporation and Ameriprise Financial have qualified for aid but have said they will decline it.

Shares of Prudential, which rose to $46 in the two days after its earnings report, have since fallen, closing at $39.59 on Tuesday. But they are still well above the company’s low this year of $16.41.

Mr. Larson said Prudential was benefiting from both a rising stock price and the approval for asset relief money. He recently raised the letter grade he assigns the company to a D, from an F. But he added that he did not think the market really understood just how much of the wind in Prudential’s sails came from a one-time accounting change. “The market is not perfectly efficient,” Mr. Larson said.

Robert DeFillippo, a spokesman for Prudential, confirmed Mr. Larson’s analysis but said the company had made no attempt to confuse investors. “We took advantage of the change in the guideline, and we fully disclosed that,” he said. Prudential’s capital levels have been a matter of some concern in the harsh economic environment of the last few months. Life insurers suffer in bear markets because they have huge investment portfolios, and investment losses have been eating away at their capital. The insurers market themselves on the basis of strength and stability — Prudential’s logo depicts the Rock of Gibraltar — and when an insurer’s capital is eroded, its credit rating can fall, making it hard to win new business.

In a study issued Tuesday, A. M. Best showed how severe the consequences can be. It found seven providers of life insurance, health insurance and annuities whose capital became so depleted over the last year that they had to be taken over by regulators. The list included Fremont Life Insurance of California, the Republic American Life Insurance Company of Texas, Standard Life Insurance Company of Indiana and Shenandoah Life Insurance of Virginia.

An error has occurred. Please try again later.

You are already subscribed to this email.

A major cause was investment losses; some companies had invested heavily in mortgage-related assets like the stocks of Fannie Mae, Freddie Mac and Washington Mutual.

The A. M. Best report said it expected more regulatory takeovers in the next two years. While the company’s analysts said they still considered most life insurers to have adequate capital, the levels were lower than usual and replenishing capital has become difficult and expensive, if available. Gradient Analytics warned in February that it considered Prudential’s capital position “precarious.”

Other securities analysts have been peppering Prudential with questions, in recent conference calls, about whether it had enough capital to avoid credit downgrades, or to pay its obligations to investors, $3 billion of which will come due in June.

At the company’s annual meeting held this month, the chief executive, John Strangfeld, said observers were painting “virtually all companies with the same negative brush.”

In a world of “have” and “have-not” insurers, he said, Prudential belonged to the haves. “Our aspiration is to gain ground, while our competitors are distracted or compromised,” he said, calling first-quarter earnings “not great, but respectable, given the times.”

Mr. Larson, the analyst, sees things differently. Without the accounting change, he said, Prudential would have reported a loss of up to half a billion. That is not as bad as Prudential’s fourth quarter, when it lost about $1.6 billion, but still worse than the third quarter of 2008, when the company lost $176 million on a consolidated basis.

The new accounting method, approved by the Financial Accounting Standards Board on April 2, followed months of loud complaints from companies that fair-value accounting was much too strict. Opponents, who got a sympathetic hearing in Congress, said fair-value accounting was harmful in this market environment, because it was forcing financial companies to post losses on their investment portfolios, even if they did not plan to sell the sunken assets.

The losses were scaring investors and driving down stock prices even more. Members of Congress signaled that if the accounting board did not do something they would.

The new method gives companies a great deal more leeway to decide which assets to mark down, and how much of the reduction to apply to their bottom lines. In Prudential’s case, it allowed the company to cut its investment losses roughly in half before taking charges to its earnings.

Some of the large commercial banks, including Wells Fargo and Citigroup, have been quick to adopt it. But Citigroup has said that the new guideline “will have no impact” on its financial statements.